Matrix Financial Services Corp. v. Frazer

Appellant Matthew Kundinger received a default judgment against Louis and Linda Frazer (the Frazers) before the Frazers closed a refinance mortgage with Matrix Financial Services Corporation (Matrix). In Matrix's foreclosure action, the master-in-equity granted Matrix equitable subrogation, giving the refinance mortgage priority over Appellant's judgment lien. Appellant counterclaimed, alleging his judgment had priority over Matrix's mortgage because it had been recorded first. Matrix, attempting to gain the primary priority position, then sought to have the refinance mortgage equitably subrogated to the rights of its January 2001 mortgage. The master-in-equity granted Matrix's request, and Appellant appealed that order. Upon review of the applicable legal authority, the Supreme Court found that a lender that refinances its own debt is not entitled to equitable subrogation. The Court reversed the lower court's decision and remanded the case for further proceedings.

In
1998, Appellant brought suit against the Frazers in California. In 2000, the
Frazers moved to South Carolina, and defaulted in Appellant's California
lawsuit.

In January 2001, the Frazers purchased a home in Greenville
County. That mortgage was assigned to Matrix in June 2001. In September 2001,
Matrix and the Frazers entered into a loan commitment to refinance the January
2001 mortgage. A title search was conducted on September 18, 2001. The
parties closed the refinance loan on November 26, 2001, but the new mortgage was
not recorded until April 3, 2002.

Meanwhile, on September 4, 2001, Appellant obtained a default
judgment against the Frazers in California, and enrolled that judgment in
Greenville County on October 31, 2001.

The Frazers filed bankruptcy, and Matrix sought to foreclose its
November 2001 refinance mortgage. Appellant counterclaimed, alleging his
judgment had priority over Matrix's mortgage because it had been recorded
first. Matrix, attempting to gain the primary priority position, then sought
to have the refinance mortgage equitably subrogated to the rights of the
January 2001 mortgage. The master-in-equity granted Matrix's request, and
Appellant appeals that order.

Issues

I.
Did the master-in-equity err in granting
Matrix equitable subrogation to the rights of the January 2001 mortgage, giving
Matrix priority over Appellant's judgment lien?

II.
Does the doctrine of unclean hands
prevent Matrix from receiving the remedy of equitable subrogation?

Analysis

I. Equitable Subrogation

Appellant
argues the master-in-equity erred in holding Matrix was entitled to equitable
subrogation. We agree.

The requirements a
mortgagee must meet to qualify for equitable subrogation are: (1) the party
claiming subrogation has paid the debt; (2) the party was not a volunteer, but
had a direct interest in the discharge of the debt or lien; (3) the party was
secondarily liable for the debt or for the discharge of the lien; (4) no
injustice will be done to the other party by the allowance of equitable
subrogation; and (5) the party asserting the doctrine did not have actual
notice of the prior mortgage. Dedes v. Strickland, 307 S.C. 155, 158,
414 S.E.2d 134, 136 (1992).

In Dedes,
a bank refinanced its initial mortgage and sought to be equitably subrogated to
the rights of that mortgage to gain priority over the rights of an intervening
mortgagee. The Court held that the bank could not meet the elements of
equitable subrogation because it merely paid "itself [the] outstanding
debt by refinancing the balance owed" and had no "direct interest
necessitating discharge of the debt . . . ." Id. at 159, 414 S.E.2d
at 136. The Court further stated, "The record is silent as to what
secondary liability [the bank] could have had for [the mortgagor's] debt
secured by its own first mortgage lien." Id. While the Dedes Court appears to have conflated the requirements of secondary liability and a
direct interest in discharging the debt,[1] the heart of its reasoning was that the bank could not be subrogated to the
rights of its own prior mortgage. This conclusion comports with the general
view that equitable subrogation contemplates a third party satisfying the
original mortgage, not the same party to whom the original debt is owed. See Restatement (Third) of Property (Mortgages) § 7.6 cmt. e (1995) ("Obviously
subrogation cannot be involved unless the second loan is made by a different
lender than the holder of the first mortgage; one cannot be subrogated to one's
own previous mortgage."); Black's Law Dictionary (9th ed. 2009)
("Subrogation: The substitution of one party for another whose debt the
party pays, entitling the paying party to rights, remedies, or securities that
would otherwise belong to the debtor.").

Thus,
equitable subrogation is simply not a remedy available to a lender that
refinances the original debt owed to it. This seems to yield the proper
result, as opposed to the mangled logic that comes about when reasoning that a
lender refinancing the original debt owed to it cannot prove secondary liability
or a direct interest in discharging the debt. Matrix is not asserting priority
under a theory of replacement and modification. Matrix expressly pled
equitable subrogation in its reply to Appellant's counterclaim. Both Dedes,
controlling South Carolina precedent, and section 7.6 of the Restatement stand
for the proposition that a lender that refinances its own debt is not entitled
to equitable subrogation. We do not decide whether a lender that refinances
its own debt could attain priority under the theory of replacement and
modification illustrated in section 7.3 of the Restatement (Third) of Property
(Mortgages).

II. Unclean Hands

Appellant also
argues Matrix is not entitled to an equitable remedy because it closed the
refinance loan unlawfully, and thus has unclean hands. We do not believe the
doctrine of unclean hands is the appropriate basis for resolution of this
case. However, we do agree that even if Matrix met the requirements for
equitable subrogation, Matrix would be precluded from receiving that remedy
because of its unauthorized practice of law.

All real estate and mortgage loan closings must be
supervised by an attorney. Doe v. McMaster, 355 S.C. 306, 585 S.E.2d 773 (2003); State v. Buyers Serv. Co., 292 S.C. 426, 357 S.E.2d 15
(1987). Performing a title search, preparing title and loan documents, and
closing a loan without the supervision of an attorney constitutes the
unauthorized practice of law. Buyers Serv., 292 S.C. at 430–34, 357
S.E.2d at 17–19.

In Wachovia Bank
v. Coffey, 398 S.C. 76, 698 S.E.2d 244 (Ct. App. 2010), Wachovia closed a
home equity loan without the supervision of an attorney and later instituted
foreclosure proceedings. Our court of appeals held that Wachovia, having
committed the unauthorized practice of law in closing the loan without attorney
supervision, came to the court with unclean hands and thus was barred from
seeking equitable relief. In so holding, the court of appeals said:

The
unauthorized practice of law is inherently prejudicial to not only the parties
involved in the instant transaction but also to the public at large for the
reason so cogently stated in Buyers:

The
reason preparation of instruments by lay persons must be held to constitute the
unauthorized practice of law is not for the economic protection of the legal
profession. Rather, it is for the protection of the public from the
potentially severe economic and emotional consequences which may flow from
erroneous advice given by persons untrained in the law.

Similarly,
in this case Matrix hired LandAmerica OneStop to perform the title search,
prepare the documents, and close the refinance loan—all admittedly without the
supervision of a licensed attorney. Thus, Matrix committed the unauthorized
practice of law in closing the refinance mortgage, clearly violating South Carolina
law.[2]
Matrix now comes to this Court, seeking equitable relief, based upon a mortgage
contract it entered into in violation of the laws of this state.

This
Court has previously held the presence of attorneys in real estate loan
closings is for the protection of the public and that "protection of the
public is of paramount concern" in loan closings. Buyers Serv.,
292 S.C. at 433, 357 S.E.2d at 19. Enforcing this requirement will come as no
surprise to any lender. Lenders cannot ignore established laws of this state
and yet expect this Court to overlook their unlawful disregard. We take this
opportunity to definitively state that a lender may not enjoy the benefit of
equitable remedies when that lender failed to have attorney supervision during
the loan process as required by our law. We apply this ruling to all filing
dates after the issuance of this opinion.

Conclusion

For the above
reasons, we hold Matrix is not entitled to equitable subrogation. The
master-in-equity's order is

REVERSED.

BEATTY,
J., and Acting Justice John H. Waller, Jr., concur. KITTREDGE, J., concurring
in result in a separate opinion. PLEICONES, J., dissenting in a separate
opinion.

JUSTICE
KITTREDGE: I concur in result. I join
Chief Justice Toal and vote to reverse due to Matrix's unauthorized practice of
law. I would not reach the issue of whether Matrix otherwise satisfied the
requirements of equitable subrogation. Concerning the majority's broader
holding voiding a real estate mortgage secured through the unauthorized
practice of law, I join today's result because of its prospective-only
application.

JUSTICE PLEICONES: I respectfully dissent. I would affirm the master's
order equitably subrogating Matrix's refinanced mortgage to its original
mortgage, and would not impose the draconian remedy of denying equitable relief
to lenders who "fail[…]to have attorney supervision during the loan
process as required by law."

A. Equitable Subrogation

Equitable subrogation is a remedy favored by the courts, and it is
to be liberally and expansively applied. So. Bank and Trust Co. v. Harrison
Sales Co., Inc., 285 S.C. 50, 328 S.E.2d 60 (1985). The doctrine:

is founded on the fictional premise that an obligation
extinguished by a payment made by a third person is to be treated as still
subsisting for the benefit of such third person, whereby he is substituted to
the rights of the creditor when he has made such payment.

"The purpose of
subrogation is to prevent a junior lien holder from converting the mistake of
the lender into a magical gift for himself." United States v. Baron,
996 F.2d. 25 (2nd Cir. 1993) (internal citation omitted).

It appears that the
majority would agree with me that a refinancer has a right to lien priority, if
that refinancer uses the theory of "replacement and modification"
rather than equitable subrogation. Heretofore, South Carolina has used the
doctrine of equitable subrogation to restore a refinancer's lien to priority,
and I would not reverse this order because it used this theory rather than the
newly announced "replacement and modification" rule.

In 1927, this Court
held that a lender who pays the original mortgage itself, or furnishes money to
the mortgagor to pay off an existing mortgage, pursuant to an agreement by
which the lender will give a new mortgage, has the equitable right to be
subrogated to the paid-off mortgage. Enterprise Bank v. Fed. Land Bank,
139 S.C. 397, 138 S.E. 146 (1927). In this situation, the lender furnishing
the money is not a volunteer, and becomes secondarily liable for the discharge
of the first mortgage under the instruments creating the new mortgage which
require the satisfaction of the first mortgage as a condition of the giving of
the second. Id.;[3] see also James v. Martin, 150 S.C. 75, 147 S.E. 752 (1929)
(applying Enterprise Bank and quoting: “One satisfying a lien note at
the request of the property owner, upon the understanding that he is to have
new security upon the property released, acting in ignorance of a second
mortgage lien upon the property, although it is on record, is entitled to
subrogation to the rights of the first lien holder”).

As the Washington
Supreme Court explained, several considerations support a rule that, absent
material prejudice to a junior lienholder, equitable subrogation should be
automatically available to a mortgage refinancer who can show it expected to
have first priority:

1)
Equitable subrogation preserves
priorities by keeping mortgages and other liens in their proper recordation
order;

2)
Equitable subrogation
accomplishes substantial justice and rests on the maxim that no one (here, the
junior lienholder) should be enriched by another's loss;

The majority would
punish the respondent in this case for failing to anticipate the majority's
decision to alter the theory under which respondent pled, proved, and obtained
the result it sought below. I would affirm the master's decision to equitably
subrogate Matrix's second mortgage to its first, a result which is consistent
with both our existing law and sound public policy. Cf. Rule 220(c),
SCACR (court may affirm for any reason appearing in the record).

B. Unclean Hands

The majority also
would expand the relief afforded by the Court of Appeals to a mortgagor who has
been the "victim of the unauthorized practice of law" to all
lienholders of that mortgagor. See Wachovia Bank v. Coffey, 398
S.C. 76, 698 S.E.2d 244 (Ct. App. 2010) cert. pending (mortgagee cannot
foreclose mortgage where loan closed without attorney supervision); compare Hambrick v. GMAC Mort. Corp., 370 S.C. 118, 634 S.E.2d 5 (Ct. App. 2006) cert. dismissed April 5, 2007 (mortgagor has no private right of action
against mortgagee for the unauthorized practice of law). The purpose of
equitable subrogation/replacement and modification is to prevent a windfall to
a junior lienholder. I cannot square the policy underlying this purpose with
the Court's proclamation that refusing equitable relief to "bad"
lenders will somehow protect the public at loan closings. I see only detriment
to the borrowing public[5] and a windfall to junior lienholders in this decision which would deny all
equitable relief to any "lender who fail[s] to have attorney supervision
during the loan process as required by our law…[in] all filing dates[6] after the issuance of this opinion."

CONCLUSION

I respectfully
dissent and would affirm the Master's order.

[1] The logic surrounding the elements of secondary liability and direct interest
has been tortured in our case law because the current definition does not
distinguish between a party who pays off the prior debt and a party who
advances funds to the debtor for the purpose of paying off the prior debt.
Judge Howard's concurrence in Dodge City of Spartanburg, Inc. v. Jones,
317 S.C. 491, 454 S.E.2d 918 (Ct. App. 1995), explains the difficulties our
courts have encountered concerning this issue. While we disagree with Judge
Howard's conclusion that the lender in Dodge City could receive
equitable subrogation when it refinanced the debt already owed to it, we agree
with his analysis that a lender who either pays the debt itself or provides the
debtor funds with the understanding the debtor will satisfy the obligation may
seek equitable subrogation.

[2] Buyers Service established in 1987 that attorney supervision is required
for the four steps in the residential real estate loan and mortgage process:
preparation of deeds, notes, and other instruments; preparation of title
abstracts; the closing; and recording the instruments. 292 S.C. at 430–34, 357
S.E.2d at 17–19. No language, analysis, or discussion in Buyers Service indicates the Court intended to limit the holding to purchase money mortgages.
In Doe v. McMaster, the petitioner suggested to the Court that Buyers
Service's holding did not apply because the buyer and lender were
refinancing an existing mortgage rather than purchasing new property. 355 S.C.
at 312, 585 S.E.2d at 776. The Court said, "This distinction is without
significance" because "[i]n refinancing a real estate mortgage the
four steps in the initial purchase still exist." Id. Doe v.
McMaster did not change the landscape regarding refinance loans, but simply
stated the existing law.

[3] It appears that the lender in Dedes v. Strickland, 307 S.C. 155, 414 S.E.2d 134 (1992) was denied equitable subrogation because it failed to present
evidence that its refinancing was conditioned upon the repayment of the first
loan. Id. at 159, 414 S.E.2d at 136.

[5] I suspect that many mortgagees, denied hope of equitable relief, including the
ability to foreclose if an attorney should fail to supervise any of the acts
required of him in a loan closing, will choose not to do business in South
Carolina, or choose to increase fees to cover potential unrecoverable
liabilities.

[6] I am unsure what filing date the majority is referring to in this passage.